Buy and Hold Works….Until It Doesn’t
Buy and Hold is considered by many to be the holy grail of investing. Its current popularity has become a cult-like strategy that draws criticism to its critics and disdain towards those who dare speak out against the beloved investing strategy.
I’m going to explain why a buy and hold strategy is useful for some investors and a good strategy at certain periods of time. We’re also going to explore why buy and hold is not the best strategy for many investors, and is a poor strategy for everyone at certain periods of time.
Buy and Hold Strategy Definition
Investopedia provides the following definition:
“Buy and hold is a passive investment strategy in which an investor buys stocks and holds them for a long period of time, regardless of fluctuations in the market.”
There are many different ideas of what buy and hold means, but I like this definition because it’s fairly simple. The only wiggle room in the definition is: What is “a long period of time”?
Some investors might consider one year a long period of time. I believe we are living in an era where investors have “short-term-itis”. Many more people would consider 3-5 years a long period of time. This may be because in relationship to 1 year it is long.
However, for our discussion I’m stipulating that a long period of time is 10 years or more. Anything less than that it’s difficult to use reasoning or logic that includes probabilities. The shorter the time period the more randomness and fluctuations affect returns. If your not thinking longer than 10 years, you are not really thinking “long term”.
Advantages of Buy and Hold Investing
Easy to implement. The ultimate in passive investing: buy and hold. Simple as can be?
Saves on taxes. Long term capital gains and dividends are taxed lower than short term capital gains.
Efficient. Saves on commissions, transaction fees, etc.
No Need For Market Analysis. Market timing is avoided, volatility is ignored.
Investment Vehicles Add to Simplicity. Low-cost index and ETF funds are perfect investment vehicles for buy and hold investing.
Disadvantages of Buy and Hold Investing
Premium Prices. Most of the stocks worthy of buying and holding are priced at a premium. (Buying high) If you’re going to buy a stock to hold for more than 10 years, it better be a premium company!
Investor Panic. Many investors who claim to be buy and hold investors change their mind after large losses, leading to large drawdowns. (Selling low)
Volatility is ignored. Volatility is not always a bad word. Many successful value investors look at volatility as opportunities to buy bargains and sell trendy overpriced investments.
Ignoring Market Analysis. Market analysis can determine periods of time where it is problematic to be heavily invested or opportunistic to be aggressive.
Interested in Dividends?
“The underlying theory of buy and hold investing denies that stocks are ever expensive, or inexpensive for that matter, investors are encouraged to always buy stocks, no matter what the value characteristics of the stock market happen to be at the time.”
Ken Solow (Buy and Hold is Still Dead)
Find the Best Strategy For YOU
If you are the type of person who has little interest in learning how to invest, buy and hold may be the right strategy for you. The problem is you may not have much interest in your investments until they have major declines in value.
A buy and hold strategy requires equal attention to the “hold” part. You can’t sell after you have a 50% decline and be a true buy and hold investor.
In the long run a true buy and hold passive investor will most likely achieve average rates of return. If you systematically invest over your lifetime you will make purchases at bargain prices and at expensive prices. It may all equal out.
A buy and hold strategy does well in bull markets when stocks are consistently rising. But the reality of the stock market is that stocks go through long periods where values decline or stay flat. Sometimes these periods last a couple of decades. Usually these periods are preceded by periods when stocks become very expensive and overvalued when compared to their historical relationships to earning, cash flow, book value, etc.
For an investor willing to make the effort it makes no sense to take the same approach to buying stocks when they are bargains versus when they are expensive. An investment has more upside and less risk when its price is low. That same investment has less upside and greater downside risk when the price is expensive.
“In almost every walk of life, people buy more at lower prices; in the stock market they seem to buy more at higher prices.”
This kind of behavior makes no sense. Therefore, buy and hold passive investing works when prices are bargains or even fairly valued. At any other time, your probability of success is greatly reduced.
So buy and hold works….until it doesn’t. People will quote all kinds of statistics “proving” that buy and hold works. Its the trend of our day. This is nothing new. Bull markets make buy and hold look good. Bear markets make buy and hold look bad.
Consider where you think we are in the valuation cycle before you make your buy and hold investing strategy decision!
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